By Greg Moses
In my crash course on market theory (let the pun stand) no discovery has been more interesting than the Elliott Wave.
As the story goes, Charles Nelson Elliott was too sick to do much more than to study stock charts. In the charts he discovered a coherent form that is today called the Elliott Wave.
The guru of contemporary Elliott Wave theory, Robert Prechter, describes the basic form of the Elliott wave in terms of two connected zig-zag patterns. First there is the five section zig-zag of which the first, third, and fifth sections move in the direction of the main trend while the second and fourth sections correct the trend. Next comes a three section zig-zag that corrects the overall trend of the five sections that came before it.
Furthermore, the wave structure is fractal in nature, which means that zooming in or out of a chart pattern will yield different levels of form in which each level remains faithful to the basic pattern.
In The Elliott Wave Theory co-authored by Prechter and A.J. Frost in 1978, the large pattern was described as bullish. Another book by Prechter in 2002, titled “Conquer the Crash” discusses a general downward reversal of the Elliott Wave pattern.
Of course it is difficult to match up the spirit of Capitalism with a market price theory that is fractal. Whatever can the wave be expressing if not the rational push and pull of supply and demand.
As a first reply to the skeptic, we may note that the theory of price as a reflection of a rational market has apparently waned out of favor even among mainstream theorists who are not proponents of the Elliott Wave.
As Prechter explains the background theory, the Elliott Wave traces the disclosure of collective moods of optimism or pessimism. Down markets don’t depress us; it is our depression that takes the market down. With up markets it’s just the reverse. We get into states of euphoria.
Contrast the recent experience of the credit bubble with the mood we seem to be in today. Invincibility was the collective mood then. Today, vulnerability closes in.
The coherence of the Elliott Wave theory appears to be impressive. It reminds me of two things. First there were the Pythagoreans who taught that everything is number. They probably got it from the pyramid builders. What is there about a pyramid that is not a testament to the truth of pure numbers as form?
The second thing that the Elliott Wave reminds me of is the theory of synchronicity advanced by Carl Jung. Although Prechter discusses the Elliott Wave phenomenon as one-way causal where mood causes market fluctuation, Jung’s theory of synchronicity is more agnostic about the relationship between matter and psyche. What Jung could say is that matter and psyche move together.
Actually, there is a third thing that the Elliott Wave calls to mind. In the Ethics of Spinoza, freedom appears to be identical to understanding. One is free of a determination as soon as one understands it.
Disclosure: positions in cash.